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What Is a Reverse Mortgage?

Many Americans facing retirement would love to increase their monthly income. Fortunately, there is a way that homeowners can use their homes to help finance their retirement — to turn the value of their property into usable cash without the emotional trauma of having to sell and move.

A reverse mortgage turns the value of your home equity into usable cash, which you can use to supplement your income, finance home improvements, pay medical bills or debts, or even fund a family member’s college education. Instead of you making monthly mortgage payments, the lender pays you in the form of fixed monthly payments for the rest of your life, or as a lump sum or a line of credit that can be tapped when needed (up to a certain limit). The income you receive is generally tax-free and doesn’t affect your Social Security and Medicare benefits.

To be eligible for most reverse mortgages, you must be age 62 or older and the home must be your principal residence. Even though this is a home loan, you don’t have to repay the principal, interest, and fees for as long as you (and usually your surviving spouse) continue living in the home or the property is sold.

With a reverse mortgage, you can effectively annuitize your home. The monthly payment you receive is computed using standard annuity methods that take into account your age and life expectancy (as well as your spouse’s life expectancy if you are joint borrowers), the appraised value of the property, current interest rates, the type of distribution you choose, and the amount of equity that you assign to the loan company.

For example, you may choose to take the loan against only 50% of the equity stake in your house. This would obviously result in a reduction in the size of your monthly check compared with a higher equity percentage. If property prices decline after you take out a reverse mortgage, it will not affect the remainder of your estate; in such circumstances, the lending company bears the loss. This is similar to a traditional annuity in which the insurance company bears the loss of continuing annuity payments in the event that you live past your life expectancy.

And even though you will never owe more than the value of your home when the loan becomes due (upon your death or when you no longer live in it), keep in mind that home values have the potential to increase over time. However, if the remaining equity is lower than the appraised value of the property, your heirs might have a hard time paying back the loan if they want to keep the home rather than sell it.

You do need to exercise some caution before undertaking a reverse mortgage. You are still responsible for paying property taxes, homeowners insurance, and all repairs. The costs associated with a reverse mortgage are generally higher than a traditional mortgage and can include an origination fee, closing costs, and servicing fees over the life of the mortgage. Reverse mortgages typically have variable interest rates, which could rise over time. Although monthly interest will accrue on the loan balance, it is not tax deductible as it is with a traditional mortgage.

The Home Equity Conversion Mortgage (HECM) is a federally insured reverse mortgage that is generally less expensive than private-sector reverse mortgages, though you typically are charged mortgage insurance premiums.

If a reverse mortgage meets your needs and lifestyle objectives, it could be one way to increase your monthly income during your retirement years. However, because of the costs and conditions involved in a reverse mortgage, you should weigh your options carefully and consult with a professional who can explain the full implications.